154: Accounting Changes and Error Corrections
Robert Bloom and Jayne Fuglister
MARCH 2006 - Since
2002, FASB and the International Accounting Standards Board
(IASB) have had formal convergence projects in the works.
The two standards-setting bodies are actively engaged in harmonizing
their accounting standards. One prominent example is the new
SFAS 154, Accounting Changes and Error Corrections,
which replaces APB Opinion 20 and SFAS 3. SFAS
154 is very similar to IAS 8, Accounting Policies, Changes
in Accounting Estimates and Errors, which was revised
in December 2003. Both FASB and the IASB have modified their
standards on changes and errors to achieve international uniformity
and comparability in financial reporting changes and errors.
presents a summary of the issues addressed by SFAS 154 and
how its treatment of accounting changes and errors differs
from APB 20 and SFAS 3. The Sidebar
illustrates two numerical applications of the new standard.
in Accounting Principles
20, “Accounting Changes” (1971), generally required
the cumulative effect of changes in accounting principle—from
one GAAP to another—to be reflected in current earnings.
SFAS 154 calls for “retrospective application”
for voluntary changes in accounting principle. This standard
uses the term “restatement” to refer to revision
of previously issued financial statements to correct an
error. The new standard enhances consistency for the same
company across time and improves comparability with companies
that use International Accounting Standards.
application means that a change in accounting principle
is treated by restating comparative financial statements
to reflect the new method as though it had been applied
all along. Instead of showing the cumulative effect of the
difference between the two accounting principles in the
current income statement, this figure will now be reflected
as a retrospective application and an adjustment to the
opening retained earnings balance. Thus, the new term “retrospective
application” implies that the company should apply
the new standard it adopted to all periods shown unless
it is impracticable to determine the cumulative effect or
the period-specific effect of the change. The “exceptional”
retroactive method required by APB 20 for a change from
LIFO to another GAAP inventory method, a change in accounting
for long-term construction contracts, and a change in accounting
for the extractive industries will now be the norm for most
accounting principle changes. The cumulative effect will
no longer be used.
that SFAS 154 requires that, when practicable, retrospective
application be presented with respect to the direct effects
and related income tax effects of a change in principle.
Indirect effects, such as changes in management compensation
and certain royalties, are not to be included in the retrospective
application. If indirect effects are recognized, they should
be reflected in the period of the accounting change.
in Methods or Estimates
in depreciation, amortization, or depletion method.
In a significant change from existing practice, SFAS 154
requires that changes in depreciation, amortization, or
depletion methods will now be viewed as changes in estimate
that are effected by a change in accounting principle. As
such, these changes will be handled prospectively:
would] … better reflect the fact that an entity
should change its depreciation, amortization, or depletion
method only in recognition of changes in estimated future
benefits of an asset, in the pattern of consumption of
those benefits, or in the information available to the
entity about those benefits. … The
Board considers a change in depreciation, amortization,
or depletion method to be inseparable from the change
in the estimated consumption pattern.
in accounting estimate. A change in accounting
estimate, such as in a bad-debt allowance, a warranty liability,
or the service life of an asset, is not an error, because
these estimates were based on the best information available
at the time. These changes will continue to be treated prospectively,
as under APB 20. However, if a change in estimate affects
several future periods and materially affects the current-period,
disclosure of the effect of the change on current income
from continuing operations, net income and the corresponding
earnings-per-share figures is required.
from FIFO to LIFO. Under APB 20, a change
from FIFO to LIFO was treated as a change in estimate, because
of the difficulty of determining prior LIFO inventory layers.
Under the new standard, this change may continue to be treated
it is impracticable to determine the cumulative effect
of applying a change in accounting principle to any prior
period, the new accounting principle shall be applied
as if the change was made prospectively as of the earliest
is retrospective application impracticable? Impracticability
of retrospective application occurs, according to SFAS 154,
if any of the following conditions prevail:
making every reasonable effort to do so, the entity is
unable to apply the requirement.
application requires assumptions about management’s
intent in a prior period that cannot be independently substantiated.
application requires significant estimates of amounts, and
it is impossible to distinguish objectively information
about those estimates that:
Provides evidence of circumstances that existed on the
date(s) at which those amounts would be recognized, measured,
or disclosed under retrospective application, and
have been available when the financial statements for
that prior period were issued.
of errors. As under APB 20, the correction
of an error, which may be a change from one non-GAAP method
to GAAP, or a bookkeeping correction, is shown as a restatement.
Error corrections are distinguished from changes in GAAP,
which are considered retrospective applications. Thus, although
error corrections, like changes in principles, are reflected
by restating comparative financial statements along with
a prior-period adjustment to the opening retained earnings
balance, the term “restatement” is reserved
for error changes. SFAS 154 retains accounting for error
corrections as in APB 20; there is no exception due to impracticability.
adoption of a new principle. SFAS 154 prescribes
that initial adoptions follow the transition provisions
required in the new accounting principle. If there are no
transition provisions, the statement requires retrospective
application to the extent possible. If retrospective application
is impracticable, then the adoption is treated prospectively.
Limited retrospective application is to be used if full
retrospective application is impracticable.
in reporting entity. Changes in reporting
entity are shown as prescribed in APB 20, that is, the restatement
of all comparative statements. The nature of the change
in entity and the reasons for the change are described in
the notes to the financial statements. In addition, the
effects of changes on income before extraordinary items,
net income, other comprehensive income, and related per-share
amounts are disclosed for all periods presented.
changes. Changes in accounting principles
made in an interim period or at the end of the fiscal year
are applied to all interim periods of the year of change.
Disclosure of the effect of the change on income from continuing
operations, net income, and related per-share amounts is
required for interim periods in the year of change. If a
company reports interim information and makes an accounting
change during the fourth quarter of its fiscal year and
does not report the data in a separate fourth-quarter or
annual report, disclosure of the nature and justification
for the change and the effects of the accounting change
on interim statements must be made in a note to the financial
statements. If it is impracticable to distinguish between
the cumulative effects on prior years and the effects on
the interim periods of the year of change, then the accounting
principle change in the interim period is not allowed.
of Disclosure Requirements
disclosures required under the new standard are similar
to those under APB 20. For voluntary changes in accounting
principle, the entity must disclose the following:
The change in accounting principle, and why the new one
2. The method of applying the change, including its retrospective
effects on income as well as other items affected, the
cumulative effect of the change in retained earnings at
the start of the first period presented. If retrospective
application is not practicable, the reasons why and how
the change was reported.
3. If indirect effects of a change in principle are recognized,
a description of them, including the total and per-share
amounts reflected in the current period. If practicable,
the total indirect effects pertaining to each prior period
addition, disclosure is required for the portion of any
indirect effect recorded in the current period, but related
to specific prior periods shown, if it is practicable to
determine this amount. When a change is made to conform
to a new standard, the same disclosure requirements apply
as those for voluntary changes in standard unless the new
standard indicates otherwise.
corrections. The nature of an error must be
disclosed, as well as the effect on the current and prior
periods presented. In addition, if an error affects the
current or prior periods presented or is expected to affect
subsequent periods, the entity must disclose that comparative
information has been restated, the effect of the correction
by line-item and per-share amounts for all periods presented,
and the amount of the adjustment to opening retained earnings.
in accounting estimate. If a change in accounting
estimate has a material effect on current and future periods,
the nature and amount of the effect on income from continuing
operations, net income, and related per-share amounts of
the current period must be disclosed. For a change in estimate
effected by a change in accounting principle (such as a
change in depreciation, amortization, or depletion method),
the entity must justify why the new method is preferable,
state the effect on current and prior periods, and provide
the same disclosures required for a change in accounting
154 becomes effective for fiscal years beginning after December
15, 2005. The effective date is in essence one year later
than the IAS 8’s effective date, which is January
154 and IAS 8 as revised in December 2003 are a direct result
of FASB’s and the IASB’s commitment to converge
their accounting standards. SFAS 154 modified APB Opinion
20, which was inconsistent with IAS 8, thus enhancing comparability.
Other modifications of FASB standards aimed at convergence
will follow. It will be interesting to see whether the new
standard results in U.S. companies’ making these changes
more frequently. The SEC can be expected to continue to
scrutinize changes in accounting principle to guard against
potential abuses, such as using changes in accounting principle
to manage earnings.
Bloom, PhD, is a professor of accountancy at John
Carroll University, University Heights, Ohio.
Jayne Fuglister, DBA, is a professor in the
department of accounting, Nance College of Business Administration,
Cleveland State University, Cleveland, Ohio.